Cover: Costs of a Medicare Prescription Drug Benefit

Costs of a Medicare Prescription Drug Benefit

A Comparison of Alternatives

Published 2002

by Jesse D. Malkin, Geoffrey F. Joyce, Dana P. Goldman

Research Brief

Medicare is the only large health insurance carrier that does not include an outpatient prescription drug benefit. This exclusion is particularly important because the elderly are among the biggest consumers of pharmaceuticals. Medicare beneficiaries comprise 13 percent of the U.S. population, yet account for over 36 percent of total outpatient drug expenditures. Private arrangements—principally employer-sponsored insurance—often fill this gap, but additional coverage comes from Medicaid, individually purchased private plans like Medigap, and health maintenance organizations. In addition, many states offer some type of prescription drug benefit to the elderly and disabled.

Numerous plans have been proposed to add a prescription drug benefit to Medicare, but none has been implemented, primarily because of concerns about program cost.

To provide information that could inform policy decisions, a RAND Health team led by economists Dana Goldman and Geoffrey Joyce constructed a microsimulation model to predict drug expenditures in 2001 for a representative cohort of Medicare beneficiaries under the status quo and three different plans: (1) a catastrophic plan modeled on the Medicare Catastrophic Coverage Act, (2) a zero-deductible plan that caps out-of-pocket expenses at $4,000 per year, and (3) a zero-deductible plan that does not cap out-of-pocket expenses.

Their key findings:

  • A Medicare prescription drug plan with no deductible would cost $11–$14 billion per year, depending on whether or not the plan caps out-of-pocket expenses.
  • Beneficiaries are not well protected against very high drug expenditures unless out-of-pocket expenses are capped.
  • A catastrophic plan could provide this protection at roughly half the cost.
  • Even under the catastrophic plan, nearly two million beneficiaries could still face substantial out-of-pocket drug expenses.

Defining Features of the Plans

Table 1 summarizes the features of the plans that the RAND team compared. The zero-deductible plan with no cap pays half the cost of prescription drugs up to a maximum annual benefit of $1,000. Payment under the other zero-deductible plan is more complicated. The government pays 50 percent of the first $2,000 in drug expenditures, the beneficiary pays for all expenditures between $2,000 and $5,000, and the government pays for all expenditures over $5,000. Thus a beneficiary's total out-of-pocket expenses are capped at $4,000, and there is no maximum annual benefit. Both zero-deductible plans have a monthly premium of $25.

Table 1. Comparison of Features of the Plans

  Zero-deductible with no cap on out-of-pocket expenses Zero-deductible with $4,000 cap on out-of-pocket expenses Catastrophic
Premiums $25/month $25/month $10/month
Deductible $0 $0 $1,000–$3,000
Percentage paid by beneficiary after deductible is met 50% 50% 0%
Maximum annual benefit $1,000 No maximum No maximum
Medicaid-eligible Medicaid pays premiums and copayments Medicaid pays premiums and copayments Status quo
Non-Medicaid eligible with income:
Below 135% of federal poverty level (FPL) Medicare pays Part D premium and copayments Medicare pays Part D premium and copayments Medicare pays Part D premium
Between 135% and 150% of FPL Medicare pays part of Part D premium Medicare pays part of Part D premium Medicare pays Part D premium
Above 150% of FPL No subsidies No subsidies No subsidies

Under the catastrophic plan, Medicare beneficiaries pay 100 percent of the cost of drugs up to a deductible that depends on the beneficiary's income; beneficiaries are fully covered for drug expenditures above the deductible. The deductible is $1,000 for those with incomes less than 150 percent of the federal poverty level (FPL); otherwise it is 10 percent of income up to a maximum of $3,000. The plan has no premium for beneficiaries with household income up to 150 percent of the FPL; all other beneficiaries pay a $10 monthly premium reflecting 25 percent of the plan's actuarial value.

All three plans would be included as a voluntary outpatient prescription drug benefit under Medicare, denoted in the table as Medicare Part D. The researchers assumed that under all three plans, people whose employer-based insurance had more generous drug coverage would not switch to the government plan. Since the catastrophic plan is less generous than virtually all existing employer-based plans, almost no one with private insurance would switch to the catastrophic plan.

Estimating Costs of Prescription Drug Coverage

To estimate the cost of prescription drug coverage, the researchers drew on data from the 1995 Medicare Current Beneficiary Survey (MCBS), a rotating panel survey of about 12,000 aged and disabled beneficiaries. The MCBS contains expenditures for prescription drugs in 1995; the research team inflated these expenditures to 2001.

To compute the average coinsurance rate (the percentage paid by the beneficiary after the deductible is met) under a Medicare prescription drug benefit, the researchers estimated drug expenditures, Medicare payments, and out-of-pocket spending given the benefit structure of each plan and status quo levels of spending. They then used these estimates to compute the average coinsurance rate by type of supplemental coverage. The average coinsurance rate ranges widely, from 17 percent for beneficiaries enrolled in Medicaid to 79 percent for enrollees who have Medigap insurance without drug coverage.


Table 2 summarizes overall costs and cost per beneficiary for each of the three plans. The figure shows the estimated number of beneficiaries who would have various levels of out-of-pocket expenditures under each plan.

Table 2. How Much Alternative Medicare Prescription Drug Plans Will Cost the Government and Beneficiaries

  Status Quo Zero-deductible with no cap on out-of-pocket expenses Zero-deductible with $4,000 cap on out-of-pocket expenses Catastrophic
Total Plan Costs (in millions; 2001 dollars)
Medicare payments n/a 13,540 15,330 6,080
Employer premium subsidies n/a 890 1,160 960
Rx coverage for Medicaid beneficiaries n/a 2,790 2,910 0
Total federal outlays 17,220 19,400 7,040
Less: premium revenues n/a –5,640 –5,770 –2,000
Net federal cost 11,580 13,630 5,040
Per Beneficiary Costs (2001 dollars)
Total Rx expenses $1,460 $1,400 $1,410 $1,340
Out-of-pocket Rx expenses 650 460 440 650
Out-of-pocket premiums n/a 160 170 60

Number of Beneficiaries with High Annual Out-of-Pocket Expenditures Under Each Scenario

The two zero-deductible Medicare drug plans would cost between $11.6 billion and $13.6 billion in 2001. Under the zero-deductible plan with no cap, almost two million beneficiaries would still face drug costs of more than $2,000, and about half of these would have out-of-pocket expenditures of more than $3,000. Increasing the annual plan payment to $2,500, as has been proposed, would increase protection against catastrophic costs but would increase the cost of the plan to $15.4 billion in 2001.

The zero-deductible plan that limits out-of-pocket expenses to $4,000 has the lowest per-beneficiary out-of-pocket costs ($440) and provides complete insurance against expenses above $5,000. However, under this plan beneficiaries pay all drug costs between $2,000 and $5,000, so even more beneficiaries could have expenses between $2,000 and $4,000 than under the zero-deductible plan with no cap. Eliminating this additional burden by allowing 50 percent coinsurance up to $5,000 would raise the plan's cost to $16.9 billion in 2001.

The catastrophic drug plan would cost approximately $5.0 billion in 2001. Removing the $10 monthly premium from the catastrophic plan—making it free to everyone—would raise the cost to $7.0 billion. The catastrophic plan would provide substantial protection against expenditures over $3,000. But the researchers estimated that about 250,000 beneficiaries who elected to stay with their employer-based plan could face out-of-pocket drug expenditures of more than $3,000.

Low-income beneficiaries are protected under all three plans: They pay a maximum of $1,000 in out-of-pocket expenditures.


A Medicare prescription drug plan with no deductible would cost $11–$14 billion per year. However, if the plan does not cap out-of-pocket expenses, beneficiaries have little protection against catastrophic drug expenditures. A catastrophic plan would be relatively inexpensive and could provide this protection.

The estimates presented here are for 2001. It is uncertain how these cost estimates will change over time. Prescription drug expenses have been growing rapidly; the size of the Medicare population is increasing; and enactment of a prescription drug benefit could cause prices to rise. Thus, any prescription drug benefit could become quite costly.

A catastrophic plan would be valuable to Medicare beneficiaries who do not now have prescription drug coverage and would be less costly than a zero-deductible plan. From a policy perspective, implementing a catastrophic prescription drug benefit would also allow policymakers to gauge future program costs before committing to more comprehensive coverage.

This report is part of the RAND research brief series. RAND research briefs present policy-oriented summaries of individual published, peer-reviewed documents or of a body of published work.

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